Inflation and Austrian Economics

0:00Welcome back and joining us live from Auburn, Alabama in the Mises Institute is Dr. Mark Thornton. Mark, how are you doing today, buddy? I'm doing great, Al. It's great to be on the show with you here Monday morning. Well, it's good to have you on. What based on our email exchange over the weekend, you know, I had a listener send me an article from a guy who gets into some detail on fractional reserve banking and using that That is the reason that we're not seeing any inflation at the moment. I argue based on the way inflation was tallied under Ronald Wilson Reagan and also under Bill Clinton that we are seeing inflation. In fact, we are seeing a lot of it in the equities market and we're exporting a bunch of it.

0:47Could we first speak to how the U.S. exports inflation? Well, that's a very complex question, Alan, but basically, if the Federal Reserve is printing money here in the US and it's trying to drive down the value of the dollar in order to enhance our exports, what happens is that other countries react to that and they start inflating their own currencies to try to keep their currency value in line with the US dollar or even driving The Central Bank of the United States, China, Japan, and the European Union, and the European Central Bank, they're all trying to drive down the value of their currencies.

1:48And so we're seeing big-time inflation, you know, here in the U.S. and a lot of different areas, you know, when the Fed is printing money, prices are going to rise somewhere in the economy. It doesn't necessarily show up in the CPI, especially the one that the government is managing and editing over time. But we're exporting this inflation, and so, you know, the Chinese are trying to stay level with us and that's causing their prices to rise and even riots over there and they're rushing into the market to try to buy gold and silver. Prices are rising in Japan, prices are rising in particularly like in Brazil.

2:33They're having a hard time keeping inflation in check there in Brazil. So there, you know, we have a federal funds rate of one quarter of one percent. Their actively managed interest rate in Brazil is over 10%. They're trying to keep inflation at bay over there because we're exporting that inflation to countries like Brazil and around the world. Well let's talk about Japan for a moment. They're what, over 20 years now into destroying their currency and I know from the most recent Economic Report that came out of Japan their trade deficit has swollen and it's because I mean it it was increased basically because they're paying more they're not importing any more than they were a year or two ago it they're just paying more for it so I'm always baffled by how these countries think that weakening their currency is somehow helpful to their population well Alan And that's a great example of how this beggar-thy-neighbor policy amongst central banks actually backfires on the consumers and the citizens of the country that we're looking at.

3:48So Japan tried to push down the value of the yen, its currency, in order to stimulate exports. But as most people know, Japan has to import virtually all of its raw materials, all of

4:32in the end and so they're just as you as you point out they're not their quantity hasn't of imports hasn't risen but the price of them has and so that is what causes the trade deficit so that they're buying more than they're selling and you know and so they basically shot themselves in the foot as far as that aggressive inflationary fighting deflation process and you know countries is all over the world. It's not just Japan. It's all the major economies as well as Switzerland is trying to keep the value of its currency competitive, so to speak, against the euro. And Norway and Sweden and Finland are also trying to keep their currencies level with the euro. And so everybody's following this song and dance initiated by the Federal Reserve

5:56Where is it, though, that they get taught all this stuff? I mean, it just seems to me that it's common sense that the stronger your currency, the better for your people. And yet, these central bankers have always taken, at least for the bulk of my lifetime, in the opposite position, that they'll talk a strong dollar, but they do the opposite. They are always striving to weaken the dollar. Where do they get off thinking that that is helpful? I just cannot connect those dots. Well, they shouldn't be connected, Alan.

6:43It's mainstream economics, the economics that's taught in college classrooms around the country is very wrong-headed. It's Keynesian based, it's an economics where the government is playing social engineer with the economy and you know they're raising and lowering taxes, they're raising and lowering the budget deficit, they're raising and lowering the trade deficit and they're raising and lowering the interest rates as if they were an engineer on a locomotive on a railroad trying

7:44and from all the participants are accounted for in market prices, market interest rates, market value of the currency, all of those parameters have to be adjusted by marketplaces that are free and open and unmanipulated by government bureaucrats. And so it's a basic failure of economics in the classroom and the fact that Austrian and Economics is basically not taught in classrooms about how markets work. If you go into a standard, everyday, ordinary classroom around the United States, basically you'll walk in and they'll be talking about some kind of market failure. And those market failures are generally caused by previous government interventions.

8:31And so it's basically an entirely wrong-headed approach that's been in place now for half a century. Keynesian Revolution occurred during the Great Depression. It never has succeeded in practice. And basically, as you point out, the basic common sense of it, or lack thereof, means that it's never going to succeed. It's always just going to pile up increasingly larger errors, mistakes in the economy. Didn't Keynes himself recant his economic theories towards the end of his life? So you know, he didn't live very much longer than after his book basically came to fame. But a lot of observers think that Keynes would be horrified by what his practitioners and followers have succeeded in implementing once they gained power and that Keynes had more respect for markets and had more respect for the foibles of bureaucracies because he himself was a bureaucrat. Certainly a lot of the blame has to go to Keynes himself, but there's also additional blame to be dealt out with to the followers and practitioners and the people

9:49who have so-called advanced Keynesian economics. There's post-Keynesian economics and new Keynesian economics. There's all sorts of variations of Keynesian economics, but it It all basically boils down to the fact that one form of Keynesian economics or another basically is mainstream economics. It's what's in the textbook. It's what's taught in the classroom. And it's a mistaken foundation of economic analysis and it's very harmful to the economy. And when Keynesian economics is ignored and markets are allowed to work in places like Hong Kong and Singapore, Japan and Germany after World War II, we've seen is a great flowering of economic prosperity and when Keynesian economics is put into place as it is now in central banks around the world, we see this increasing economic chaos.

10:49Mark, can you stay with me for another segment? I'd love to. We're speaking with Mark Thornton, Dr. Mark Thornton of the Mises Institute and when we Welcome back and joining us for another segment is Dr. Mark Thornton of the Mises Institute over in Auburn, Alabama. Mark, thanks for staying on with us. It's great to be on the show, Alan. Well, I always enjoy having you on. When I like to talk economics, can we switch over and talk about now the money supply and a lot of the central planners, and I've heard this narrative over and over again, I heard one guy say if you hooked the inflation rate up to a heart monitor, it'd be flat lined and yet we're seeing evidence of pricing inflation everywhere, but can we first of all define Inflation in its historical context, how that was morphed into pricing inflation, and then the various ways we measure the money supply?

12:00Yeah, certainly, and this is a very important distinction to be made between Austrians and mainstream economists. Now, the Austrians following history dating back until the existence of money has always viewed inflation as an increase in the money supply. I think the standard definition of it before central banking in the United States, say, 100 plus years ago, was a political increase in the money supply. In other words, where the government engineered an increase in the money supply beyond the natural flows in terms of the values of gold and silver. And so that's what the Austrians key in on. I think everybody should key in on what the central bank is actually doing to increase or decrease the money supply and of course the natural historical tendency is for the central bank to increase the money supply and especially so when there's no constraints on it and of course the central bank doesn't have the constraint on it today that the money Money that increases has to be backed by gold and silver.

13:14And so since the establishment of the central bank in the United States in 1913, we've seen this ever-increasing tendency for government to increase the supply of money to its own benefit of course. Now on top of that, on top of that increase from the central bank, the banking system and the system itself can increase the overall amount of money in the economy by increasing the amount of loans that it creates in the economy. And so once the central bank increases the supply of money, the banking system, because it's a fractional reserve banking system, has what's often referred to as leverage, and that they can increase the supply of money simply by creating loans.

14:04No single bank can effectively increase the money supply on its own, but the banking system as a whole has this ability to increase the leverage that the Federal Reserve creates when it initiates increases in the money supply. It's all a very complicated process, but you can think of the banking system has the ability to Increase the Money Supply $10 for every $1 that the central bank creates to initiate the process. Okay, so the theory of the people who say we don't have any inflation right now is that due to the lack of lending, and I think that article totally overlooked how much lending Banking is being done to the federal government, but due to the lack of lending, that has the reverse effect of fractional reserve banking and then that actually takes money back out of the money supply.

15:06Well there, you know, obviously banks have shown a lot of reluctance to lend money into the economy. Now there's a lot of money, as you say, being lent to the government itself. And then there's a lot of money just sitting on the sidelines. Banks have, as a result of the Fed, they have a tremendous amount of excess reserves because the Fed is paying them interest not to lend the money. And so they've got a sure bet at a very low interest rate where they can lend money that that they've basically received from the Fed back to the Fed and get a small return, but it's not a very large amount.

15:52We're talking about more than, I think it's almost $2 trillion of excess reserves. Now in the past, the banking system as a whole has not held any excess reserves because they've always found it profitable to lend it out. But in this environment, banks are very reluctant to lend money long-term because they rightfully We feared that there could be price inflation and that all the loans they make today would end up being underwater for them over the long haul. So they're not interested in lending money long term to businesses and to households. And as a consequence, that's had a dampening effect on price inflation. And if that money gets out, what we're going to see is a tremendous amount of price inflation, No matter how you bother to measure it, whether it's the government CPI or your own personal basket of consumer goods that you have to go out and purchase every week and every month.

16:56But if we look around in the economy, that money is leaking out. It is increasing prices.

18:03The commodity prices in a lot of areas, even gold prices are approaching $1400 an ounce. So if you get beyond the spike up to $1800, gold is really at the historically extremely high levels. And so oil prices approaching $100 a barrel. So if you look at the broad spectrum of things, if you look at the cutting edge prices, the This is on world markets, which Americans eventually see, but not necessarily do you see them immediately. On all these marketplaces, you see very high prices, historically very high prices, and so that money is getting out, and what I fear is that if all those excess reserves of banks ever got cut loose and into the economy and then got leveraged up through the banking System, you know, I just can't imagine where prices would end up.

19:04Mark, let's talk about that notion, and we're down to about three minutes, of Bernanke is creating money out of nothing, lending it to the banks for virtually nothing, and then paying them interest on the money that the Fed lent them not to lend the money out to the rest of us. How in the world could that be helpful to the economy and what stretch of the imagination does it take to say that that activity would lower the unemployment rate? Well, it doesn't help the economy and the facts speak for themselves. What it does do is it helps the big banks because it stabilizes them. It's like giving them an IV, a morphine drip and oxygen and all that kind of stuff to try Stabilize the Patient, which is the nation's five or six largest banks that are being impacted by these policies.

20:05Those are the ones where, and Bernanke basically wrote his dissertation on what caused the Great Depression and his conclusion was that it was a failure of the central banks to bail out the large banks that caused the Great Depression. And so, you know, if you were looking around for a guy, you know, if you were a large bank and you were looking around for a guy who was interested in and willing to bail out the big banks, well, Ben Bernanke is your man because he's the guy that virtually wrote the book on, actually wrote the book on why you need to bail out the big banks if they get in trouble and that's exactly what he's done. But bailing out the big banks is not the overall economy.

20:51It's not Main Street. It's not the average ordinary economy out there. That's basically how it lines up. There's no, I don't have any expectations that bailing out the big banks is going to help the economy over the long run at all. Mark, it's been a pleasure, buddy. It flies by. This is Mark Thornton, Dr. Mark Thornton of the Mises Institute in Auburn, Alabama, and we'll have Mark on again real soon. Mark, thanks a lot, buddy. MISES.ORG